Conditionality in the International Monetary Fund
Ross Leckow
Assistant General Counsel
International Monetary Fund
May 7, 2002
Introduction
1. Conditionality is a subject of enormous controversy. In popular and academic studies on
the Fund, there is probably no term of art that is more frequently cited in support of as many
different and, at times, contradictory positions. For demonstrators seeking to shut down the
annual meetings of the Fund and the Bank, conditionality has become the lightning rod for
what they regard to be the worst excesses of the Bretton Woods institutions. For countries
seeking financial support from the Fund, conditionality represents the hurdle which they
must clear in order to convince the international community of their commitment to
economic reform. For the Fund itself, conditionality represents the most effective mechanism
through which it can ensure that Fund financial assistance is used to serve the interests of its
membership and the international monetary system as a whole.
2. One thing upon which all would agree is that conditionality has evolved considerably since
its advent in the 1950s. In particular, the past two decades have witnessed a significant
expansion in the range of measures which the Fund has attached to its financial assistance.
Throughout this process of gradual change, however, the legal nature of conditionality has
remained remarkably constant.
3. This morning, I would like to discuss the legal nature of conditionality, its essential
features and principal modalities. I will begin by reviewing the purposes of Fund financing
and the mechanisms through which it is provided. I will then turn to an examination of
conditionality’s legal nature and modalities. I will also discuss the manner in which
conditionality has evolved, including the Fund’s recent efforts to streamline it. Finally, I will
conclude by raising a number of legal issues which have emerged from this initiative.
A. Background – Essential Features and Principal Modalities
4. Let me begin with an examination of the legal nature of conditionality. In this regard, what
exactly is conditionality? While literature on the Fund often ascribes several different
meanings to the term, conditionality may be best defined as those features of a member’s
program of economic reform whose successful implementation is expressly established by the
Fund as a condition for the availability of Fund financial assistance.
5. To understand what this means, it is necessary to examine the purpose of Fund financial
assistance and the manner in which it is normally provided. As set out in Article I(v) of the
-2-
Fund’s Articles, the purpose of Fund financing is to “[t]o give confidence to members by
making the general resources of the Fund temporarily available to them under adequate
safeguards, thus providing them with opportunity to correct maladjustments in their balance
of payments without resorting to measures destructive of national or international
prosperity.” Stated simply, Fund financing is extended to members experiencing balance of
payments difficulties in order to meet a balance of payments need. It cannot be provided for
other purposes, for example, to finance the budget deficit of a member government.
6. The Articles of Agreement require that Fund financing meet two conditions. First, it has to
assist the member in addressing its balance of payments difficulties. Second, it has to be
provided under conditions that ensure that the Fund is repaid. How does the Fund normally
meet these two requirements? It is through conditionality.
7. More specifically, the Fund normally extends financial assistance to a member only if the
member is prepared to implement a program of economic reform that is designed to address
the member’s balance of payments problem. If the program is successfully implemented, the
member will be restored to a position of macroeconomic stability and will be placed in the
position where it will be able to repay the Fund. Thus, the program is both the member’s road
to macroeconomic stability and the Fund’s security for repayment.
8. The principal legal instrument through which the Fund provides financial assistance in
support of a member’s reform program is the Fund financial arrangement (the most wellknown being the stand-by arrangement in the upper credit tranches which is what I will
largely focus on this morning). A Fund arrangement is a decision of the Fund’s Executive
Board which allows the member to purchase from the Fund a specified amount over a
designated period as long as the member meets the conditions specified in the terms of the
arrangement. It is designed to provide the member with the assurance that it will be legally
entitled to purchase from the Fund, without challenge, as long as the conditions specified in
the arrangement are met.
9. In practice, a member will request an arrangement to support a program of economic
reform of one to three years in length which the member intends to implement. In support of
its request, the member will submit a policy memorandum describing in detail the measures
that will be taken and the key macroeconomic targets that will be reached over the life of the
program. As the purpose of the arrangement is to support these reform efforts, the
arrangement will be structured in a manner that ensures that the member will only be able to
draw from the Fund if the program is being successfully implemented. Thus, the
arrangement will gradually make financial resources available and will set out conditions that
will need to be met before each tranche may be drawn. The conditions which the Fund
establishes are all drawn from the member’s program. They consist of the program’s most
important macroeconomic targets and structural measures and will expressly be incorporated
into the terms of the arrangement. To make a purchase, the member must show that the
relevant targets have been met and the measures implemented.
-3-
10. In determining what constitutes Fund conditionality, it is important to remember that we
are speaking only of those aspects of the member’s program that are expressly incorporated
as conditions in the arrangement for the availability of Fund resources. This actually forms a
small part of member’s program. Other aspects of the program do not constitute
conditionality per se.
a. Types of Conditionality
11. What are the principal modalities of conditionality in a Fund arrangement? I will focus on
three principal types: (i) performance criteria; (ii) program reviews by the Executive Board;
and (iii) prior actions.
(i) Performance Criteria
12. The most common form of condition is the performance criterion. Performance criteria
may be divided into two broad categories. The first are quantitative performance criteria,
consisting of quantitative targets respecting key macroeconomic variables that are expected
to be reached over the life of the member’s program. Common examples are the level of net
international reserves, the size of the budget deficit, and the level of nonconcessional external
borrowing.
13. The second category consists of structural performance criteria, that is, structural
measures whose implementation is regarded as crucial to the success of the program. These
conditions often involve legislative reforms such as the enactment of a new banking or
bankruptcy law. With respect to both these various types of performance criteria, to be able
to draw from the Fund, the member must demonstrate that the relevant performance criteria
have been met and, on this basis, that the program is “on track.”
14. While Fund arrangements are designed to ensure that resources will only be made
available if the program is being successfully implemented, it does happen that a
performance criterion will not be met and that disbursements will be interrupted. In these
circumstances, it is open to the Executive Board to a grant a waiver for the nonobservance of
the condition and to permit the disbursement to be made. Generally, the Board will only do
so if it is satisfied that, notwithstanding the nonobservance, the program can still be
successfully implemented. Thus, the waiver will normally be granted only if (i) the
nonobservance is minor and essentially self-correcting, or (ii) in cases where the
nonobservance is more serious, the member is prepared to take additional corrective
measures to bring the program back on track.
-4-
(ii) Program Reviews by the Executive Board
15. Performance criteria serve as a valuable test in determining whether the program is being
successfully implemented but they are not the only technique the Fund uses for this purpose.
A second type of conditionality in an arrangement is a program review by the Executive
Board in which the Board reviews the implementation of the member’s program more
generally. The member will not be able to make further purchases until the review is
completed. The review will normally involve an examination of the observance of conditions
specified in the arrangement and other aspects of the program as well.
16. The Board will only complete a review if it is satisfied that the member’s program is on
track. In reaching this assessment, the Board will review both past performance and potential
implementation going forward. Board reviews give the Fund an important opportunity to
establish conditions for future drawings under an arrangement if they have not been
established at the time of the arrangement’s approval. They also allow the Fund to modify the
arrangement over time as the program is implemented.
(iii) Prior Actions
17. A third important feature of conditionality is the prior action. In deciding whether or not
to approve an arrangement, complete a review, or grant a waiver for the nonobservance of a
performance criterion, the Fund often requires that the member first take certain measures as
a prior condition to the Board’s decision. These prior actions are generally structural
measures whose implementation is so important that the Fund will not be prepared to release
any further purchases until they are taken. Prior actions are relied upon particularly where the
member’s track record of performance has not been good and the Fund doubts the member’s
commitment to its program.
18. It is only recently that prior actions have become part of the conditionality of a Fund
arrangement. Historically, the Fund often called upon members to take certain measures as
prior condition to the release of Fund financial assistance but the Fund did not expressly
incorporate these measures into the terms of arrangement as conditions. Rather, the Fund
simply sought to verify that the measures were taken before adopting its decision. The
consequence of this approach was that the misreporting of information related to the
implementation of these measures was not subject to the Fund’s Guidelines on Corrective
Action for Misreporting under Fund Arrangements. These Misreporting Guidelines allow
the Fund to take remedial action in cases where a member has made a purchase from the
Fund on the basis of incorrect information that has mistakenly led the Fund to believe that all
conditions applicable to that disbursement were met. Remedial action may not be taken for
the misreporting of information on aspects of the member’s program that are not conditions.
19. In order to ensure that the reporting of information respecting the implementation of prior
actions is subjected to this misreporting framework, the Fund has, since July, 2000, followed
a policy of expressly incorporating prior actions as part of the conditionality of the
-5-
arrangement. More specifically, Executive Board decisions approving arrangements,
completing reviews, or granting waivers for nonobservance are now adopted on the basis of
an express condition that the information provided by the member on the implementation of
specified prior actions is accurate.
b. Legal Nature of Conditionality
20. Let me now make a few comments on the legal nature of conditionality. As a starting
point, it is important to distinguish between the member’s program and the Fund
arrangement. The program of economic reform is the program of the member rather than the
Fund. In practice, these programs are effectively negotiated by the authorities of a member
country and Fund staff but the program is put in place and implemented by the member and
will only be successful if the authorities are genuinely committed to its implementation and,
in the language of the Fund, have a strong sense of ownership.
21. In contrast, the arrangement supporting the program is a unilateral decision of the
Executive Board. It is the Fund that sets these conditions and the Fund that determines
whether these conditions are met. The Fund cannot delegate to another institution the power
to establish conditions for the use of the Fund’s resources or the power to assess whether
particular conditions set by the Fund have been met. Such forms of cross conditionality are
legally prohibited.
22. The Fund arrangement creates legal rights for the member and provides the member with
a level of certainty as to what has to be done in order to receive financial assistance. At the
same time, it does not subject the member to legal obligations to meet the conditions of the
arrangement. To the extent that the member fails to meet a condition under an arrangement,
the only legal consequence which ensues is that the member will not be able to purchase
from the Fund. To understand what a Fund arrangement is, you have to understand what it is
not. As a unilateral decision of the Fund, an arrangement is not a contract between the Fund
and the member. The Fund sought to avoid subjecting a member to contractual obligations to
implement their programs and putting the member the unenviable position of being in breach
of a legal obligation if it failed to meet a condition. To provide incentives to members, the
Fund sought to minimize the legal consequences attached to failure. A member is free to
walk away from its program and the arrangement at any time.
23. The Fund’s Articles and policies impose a number of limitations on the types of measures
that may be made the subject of conditionality. First, the Fund’s Articles require that
conditionality be consistent with the Fund’s purposes. Moreover, conditionality cannot be
used by the Fund to interfere with legal rights of members that are created or recognized
under the Articles. For example, the Fund cannot establish conditions that require members
to remove restrictions on capital movements, given that capital account liberalization is not a
purpose of the Fund and the Fund’s Articles expressly recognize the right of members to
restrict capital movements.
-6-
24. The Fund’s Guidelines on Conditionality require that, in establishing conditions on the
use of its resources, the Fund “pay due regard to the domestic social and political objectives”
of members. Thus, the Fund cannot establish conditions that deal with issues that are
essentially political in nature. Moreover, the Fund could not, for example, establish
conditions that are related to the human rights record of a member. Fund policy prohibits the
establishment of conditions that would require members to reduce the level of military
spending. While the amount which the authorities of a member spend on the military may be
very important for the country’s macroeconomic position, the Fund has taken the position
that the question of military spending is so inherently political in nature that it could not be
appropriately made the subject of conditionality.
B. Recent Developments in Conditionality
25. Over the course of the past two decades, the Fund has become increasingly involved in
the reform efforts of countries experiencing economic problems that were fundamentally
different from those it had previously encountered. Fund involvement with the poorest
countries of the developing world and with the countries of the former socialist bloc has
presented the Fund with the challenge not only of bringing about macroeconomic
stabilization but the implementation of a major structural transformation of the economy.
Given the poor state of economic statistics in these countries, programs had to be designed on
the basis of very unreliable information. Finally, financial assistance was sought by
governments that, in some cases, were less than fully committed to the types of reforms the
Fund felt necessary.
26. This environment prompted a significant change in the practical application of
conditionality. To address the need for structural change, the Fund began to make much
greater use of structural conditionality in the form of performance criteria and prior actions.
In order to address deficiencies in economic information and forecasting, Board reviews
became much more common in Fund arrangements. While, historically, a one-year stand-by
arrangement would typically include one or, at most, two reviews, Fund arrangements in the
former Soviet Union, in some cases, subjected every Fund disbursement to a Board review.
Finally, in order to address concerns over a lack of ownership in some of these countries, the
number of conditions attached to Fund arrangements, in particular prior actions, grew
considerably.
27. While the reasons for these developments are, in many ways, understandable, a belief
emerged that things had gotten out of hand. It was recognized that the proliferation of
conditions attached to Fund financial assistance had undermined the authorities’ sense of
ownership of their programs. It was also believed that many of the structural conditions
established in Fund arrangements dealt with issues that were not within the Fund’s core
mandate but rather should be addressed by the World Bank.
-7-
28. As a result, the Fund is in the process of reviewing conditionality with a view to
streamlining it. While this work is ongoing, a great deal of progress has been made - this
initiative has had two principal objectives. First, efforts have been made to strengthen
member countries’ sense of ownership of their programs, in particular, by reducing the
number of conditions and giving the authorities greater choice in deciding how to reach
particular objectives. Greater efforts have been made to promote a sense of program
ownership not only amongst the governments but throughout the country’s entire society.
Members receiving financial assistance have been encouraged to publish their memoranda of
economic policies to elicit the support of their populations in program implementation.
29. The second principal objective is to ensure that Fund conditionality focuses on areas in
the Fund’s core mandate leaves other areas to other international organizations. In particular,
efforts have been made to more effectively coordinate the work of the Fund and the World
Bank. In future, Fund conditionality will normally focus only on areas within the Fund’s core
mandate such as monetary, exchange rate, and fiscal policy. Areas within the competence of
the World Bank, such as the design of the social safety net and privatization, will be left to
the World Bank. Fund arrangements will no longer establish conditions in these areas unless
they are judged to be particularly important for the success of the program.
C. Moving Forward – Issues for Discussion
30. While these initiatives are in their early stages, they do raise a number of interesting
questions.
31. First, conditionality, although streamlined, will still need to serve as an effective
mechanism for the monitoring of program implementation. The role of conditionality in
judging program implementation is important not only for the Fund as lender but also for the
rest of the international creditor community, both official and private creditors, who base
their lending to member countries on the successful implementation of a Fund-supported
program.
32. Second, while strengthening a member’s sense of ownership is important, it cannot imply
a weakening of conditionality or the safeguards that ensure the Fund will be repaid. If
strengthened conditionality cannot be used to address an inadequate level of ownership, the
Fund may only address such cases by refusing to provide financing – otherwise, the Fund
will not have adequate safeguards to ensure that it is repaid.
33. Third, the Fund’s withdrawal from structural conditionality on issues within the
competence of the World Bank cannot give rise to the establishment of cross conditionality.
Notwithstanding the formal boundaries of the Fund-supported program, the temptation may
arise for the Fund to refuse financing for countries that are not on track with a Banksupported program. The Fund will have to ensure that its decisions to approve access to Fund
resources are based solely upon the member’s observance of conditions that are set out in an
arrangement approved by the Fund and in the program supported by the Fund. The
-8-
withdrawal of Fund conditionality from areas within the domain of the World Bank means
that the member’s performance in those areas can no longer be relevant for the Fund.
34. Finally, the fact that the Fund will focus its conditions on areas within its core mandate
does not mean that the Fund will withdraw from the use of structural conditionality. The
Fund will still establish structural conditionality in areas within its expertise. This will
include conditionality directed towards the reform of the legal system in areas of importance
to the Fund such as the banking system, and the regimes for secured lending and bankruptcy.
This will mean that Fund lawyers will remain very busy for some time to come.